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Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash
flows are as follows:
a. If each project's cost of capital is 12%, which project should be selected? If the cost of capital is
18%, what
project is the proper choice?
At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%,
then the choice is reversed, and Project B should be accepted.
Before we can graph the NPV profiles for these projects, we must create a data table of project NPVs
relative to differing costs of capital.
NPV
Project A Project B NPV Profiles
$1,000
$226.96 $206.17
0% $900
2%
4% $800
6% Project A
$700
8%
10% $600
12%
14% $500
16%
18% $400 Project B
$300
$200
$100
Cost of Capital
$600
$500
$400
20%
$300
22%
24% $200
26%
28% $100
Cost of Capital
30%
$0
-5% 0% 5% 10% 15% 20% 25% 30%
c. What is each project's IRR?
Cash flow
Time differential
0 $200
1 ($490)
2 ($390) Crossover rate = 13.14%
The crossover rate represents the cost of
3 ($290) capital at which the two projects value, at
4 $410 a cost of capital of 13.14% is:
5 $410 have the same net present value. In this
6 $736 scenario, that common net present $182
7 ($200)
e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? Hint: note that B is a 6-year project.
Project A
Time period 0 1 2 3 4 5 6 7
Cash flow (375) (300) (200) (100) 600 $600 $926 ($200)
Cumulative cash flow (375) (675) (875) (975) (375) 225 1,151 951
Payback 4.625
Project B
Time period 0 1 2 3 4 5 6 7
Cash flow (575) 190 190 190 190 $190 $190 $0
Cumulative cash flow (575) (385) (195) (5) 185 375 565 565
Payback 3.026
g. At a cost of capital of 12%, what is the discounted payback period for these two projects?
WACC = 12%
Project A
Time period 0 1 2 3 4 5 6 7
Cash flow (375) (300) (200) (100) 600 $600 $926 ($200)
Disc. cash flow (375) (268) (159) (71) 381 340 469 (90)
Disc. cum. cash flow (375) (643) (802) (873) (492) (152) 317 227
Discounted Payback 5.40
Project B
Time period 0 1 2 3 4 5 6 7
Cash flow (575) 190 190 190 190 $190 $190 $0
Disc. cash flow (575) 170 151 135 121 108 96 0
Disc. cum. cash flow (575) (405) (254) (119) 2 110 206 206
Discounted Payback 3.98
h. What is the profitability index for each project if the cost of capital is 12%?